Silicon Valley Bank's demise - the second-largest bank collapse in US history - triggered a chain reaction that rapidly spread to other banks.
Signature bank, First Republic Bank, Western Alliance, and PacWest have also been affected by SVB's decline.
Nonetheless, the contagion has spread beyond regional institutions. After investors withdrew $35bn in three days, Credit Suisse was acquired by local competitor UBS.
Deutsche bank has also been surfacing in rumors as the next 'shoe to drop.' This, even though the German Finance minister Olaf Scholtz and JP Morgan have released statements assuring the public of the bank's financial strength.
The panic caused by the bank run prompted US President Joe Biden to issue a statement assuring Americans that their deposits were safe. The fact that the President of the United States had to intervene demonstrates the severity of a bank run if left unchecked.
So, what is a bank run?
And why do people believe that a crisis in one bank will have repercussions for others?
A traditional bank run occurs when too many customers withdraw all their money at the same time from their deposit accounts with a banking institution for fear that the institution may be, or will become, bankrupt.
Although bank regulators have implemented deposit insurance schemes to cover depositors, the inability to use funds or a potential loss (beyond insurance coverage) may often outweigh the customer’s trust in their institutions.
There are numerous causes of a bank run, but fear and loss of faith in a bank's ability to return entrusted funds on demand are the major culprits.
Customers may experience fear and mistrust in response to any panic-inducing event. This could include:
All because they fear the institution will fail.
Trust is the most important quality for any bank. If consumer confidence is abruptly eroded or lost, it can cause panic (Whether rational or not). With the global banking regulations in place today, bank failures are not typically the cause of bank runs.
Rather than actual collapse, public anxiety is the most common cause of a bank run, which results in inadequate liquidity.
When things are going well, you have faith in your bank. If you lose confidence, you will likely want to withdraw your funds. And if you feel this way, it's likely that others do as well. This undermines the entire system, which relies on the fact that not everyone needs their money simultaneously.
Bank runs generate negative feedback cycles that can cause the collapse of banks and a systemic financial crisis. Typically, a bank has a limited quantity of cash on hand that is less than the total amount of its deposits.
If, for example, too many customers demand their money, the bank won't have enough to return it to them.
A bank run can lead to collapse if the institution is unable to meet regulatory capital requirements. A bank run that is not managed can wipe out stockholders, bondholders, and depositors (Beyond an insured amount).
When numerous institutions are involved, an industry-wide panic may ensue, leading to a financial crisis and economic recession.
Banks only maintain a small portion of their assets in cash.
This is usually reserved for cash requirements of daily operations. Because this money is unproductive to generate a return for shareholders; banks only keep just enough to keep operations going.
A significant portion of bank deposits are held in available-for-sale or held-to-maturity instruments such as:
These assets generate returns for shareholders.
This fractional reserve system means that the bank can't pay all the customers their money when they come at the same time. This is the reason why if there is a high demand for withdrawals, the bank tends to go under.
A bank may slow down a bank run by artificially slowing down the withdrawal process. They may limit the withdrawals per customer or suspend all withdrawals altogether as a way of dealing with the panic.
This may be the followed by a complete shutdown of withdrawals. But this action is usually taken in consultation with regulators, sometimes after the close of a business day.
A bank may be forced to borrow money from other banks or the central bank if it cannot meet up with the demand for its withdrawals. If the bank is able to access the required funds, this may actually save it from bankruptcy.
The Central Bank is regraded as the lender of last resort. This means it is the banker's bank and has a responsibility to safeguard the viability of financial institutions by lending money to troubled banks and preventing a flood of bankruptcies and their negative ripple effect on the banking system.
As part of its treasury and balance sheet management, a bank can incentivize its customers to use non-callable term deposits in order to earn a higher rate of interest.
Due to the fact that it is non-callable, consumers can only withdraw their funds at the conclusion of an agreed-upon period and not on demand. Term deposits effectively seal up a bank's liabilities, allowing it to survive a bank run even if other deposits are withdrawn.
Insurance on customer deposits guarantees that in the event of a bankruptcy, customers will get their money back up to the insured amount. The standard deposit insurance coverage limit is $250,000 per depositor, per FDIC-insured bank, per ownership category.
If a bank collapses, the FDIC may facilitate a resolution. This could be an acquisition by a bank with high capital reserves to backstop a vulnerable bank (and its customers). The customers can then access their deposits under the combined bank.
A less desirable option is for the FDIC to seize the vulnerable bank and conduct an auction of the assets to raise funds to return to depositors. The sale proceeds cover amounts beyond the guarantee by the insurance fund.
Any shortfall will be covered by a change in deposit insurance premiums paid by the industry.
A bank run is when a massive influx of withdrawal requests due to loss of confidence in the bank.
In extreme cases, this can lead to the the collapse of a bank as seen in the case of Silicon Valley Bank.
Though businesses and consumers are better protected from bank failures now compared with the financial crisis of 2008, not all of the rules apply to smaller banks. Some portions of the legislation have been rolled back, which means depositors could be exposed to more risks.
To reduce your risk of losing money in a bank run, you can keep your deposits below the $250,000 per depositor and per insured bank FDIC insurance limit. If you need to deposit additional funds, you can establish an account at a different bank with the same level of protection.
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